CFM26070 - Accounting for corporate finance: foreign exchange: contractually fixed exchange rates
Exchange rates fixed by a contract
Where a company contracts to settle a transaction at a particular rate of exchange, paragraph 46 of SSAP20 requires that the exchange rate fixed by the contract must be used to record the transaction.
Example
In 2005, Selvakan Ltd buys a computer system from a US manufacturer for $800,000. The contract specifies an advance payment of $50,000, a further $400,000 to be paid on delivery, and the balance when the system has been successfully installed. All payments are to be made at an exchange rate of $1.55/£. The company acquires the computer system on 1 March 2005.
The company will record the purchase of the computer system at the contracted rate of $1.55/£ (i.e. at a cost of £516,130), regardless of the spot rate at 1 March. It will translate the payment of each instalment of the purchase price at the same rate. Thus no exchange differences will arise. Even if some of the price remains unpaid at 31 December 2005, the liability will be translated at the contracted rate.
This treatment reflects the economic reality - the company is going to have to pay precisely £516,130 for the computer system, irrespective of how exchange rates move.
FRS23/IAS21
The position is different under FRS23/IAS21. Under these standards, the use of a contracted rate of exchange to translate monetary assets and liabilities is not permitted. The closing rate as at the balance sheet date should be used instead. This is because translating an item at a rate specified in a contract is considered a form of hedge accounting not permitted under the strict criteria of FRS26/IAS39. However, it may still be possible for the contract to be accounted for at fair value under IAS39, and that any resulting gains and losses will offset any exchange gains or losses on the underlying monetary asset or liability. This would have the same effect on profit and loss as the SSAP20 treatment, or hedge accounting. If you are unsure about the accounting for contracted exchange rates under FRS23/IAS21, please consult you local compliance accountant.
